Roth vs. Traditional IRAs: Which Is Right for You?
Individual retirement accounts, or IRAs, are a great investment at any age. Whether you should invest in a Roth IRA or a traditional IRA, however, depends largely on your age.
Regardless of how old you are, it is wise to put some of your income into an IRA account to plan for your future. The two most popular types of IRA accounts—Roth and traditional—both come with their own set of rules and distinctions. But which one is a better investment for you?
The debate over these two investment vehicles almost always comes down to the numbers, often leaving the Roth IRA the victor. This is because a dollar in a Roth IRA account is almost always worth more than a dollar in a traditional IRA account. Here’s why.
Traditional IRA contributions are tax deductible on both state and federal levels for the year in which you make the contributions, whereas withdrawals made during retirement are taxed at typical income tax rates. When you contribute to a Roth IRA, on the other hand, you receive no tax break for your contributions in the year in which you make them, but withdrawals during retirement are not taxed.
In other words, with a traditional IRA, you pay taxes when you take distributions in retirement or if you make withdrawals prior to retirement (more on that below). A Roth IRA works in the opposite way: You pay taxes up front because your contributions are not deductible.
A Roth IRA is the better choice for you if you expect your tax rate in retirement to be the same as or higher than when you contribute the funds. If you are relatively early in your career, the odds are your income will be higher when you retire. Because contributions made now to a traditional IRA are tax deductible, this type of account makes more sense for people who expect their tax rate to be lower when they retire.
For both types of accounts, any earnings on your investments—including interest, dividends, and capital gains—grow tax-free.
For most traditional IRA accounts, withdrawing funds early can come with large penalties and tax punishments. For Roth IRA accounts, though, this is not the case. You can remove your contributions and whatever interest has accrued without any taxes or penalties.
If you are one of those worry warts who is nervous about locking away a certain amount of funds, the flexibility of a Roth IRA should appeal to you.
Keeping your priorities straight with regard to retirement savings can be difficult. Financial advisors want you to put your money here and there, in this and in that, and sometimes it can be overwhelming.
With a Roth IRA, there is very little risk associated with dipping your foot in the water because you can take your money out in case of any emergency. If you find yourself not wanting to put your money away in several accounts, just focusing on short-term emergency reserves and long-term retirement savings is an easy way to find a balance, and a Roth IRA is perfect for that.
One more thing to keep in mind: If you’re younger than age 50, the maximum you can contribute per year to an IRA is $5500 ($6500 if you're over age 50).